‘Free Banking’ is a Myth. Why Won’t Banks Admit It?

Remember the days when most banks offered free checking accounts? The next generation probably won’t.

To the annoyance of consumers, recent years have seen most leading banks curtail these accounts, or load them down with new restrictions. Nowadays, only 38% of checking accounts at big banks are free – down from 76% in 2009. In the words of one analyst, this amounts to “the steepest decline that I’ve ever seen, in any major financial service, ever.”

What’s going on, and who’s at fault? On a surface level, it’s tempting to blame corporate greed or clueless executives. Although both of those factors are certainly at play, the financial industry actually has a decent justification for this move. It’s surprisingly difficult for big banks to sustainably provide basic transaction accounts in today’s business and regulatory climate. Consider the challenges:

1. Free checking accounts have never been profitable for banks. They cost a lot to maintain: an estimated $250-$400 a year, with larger banks paying more due to extra overhead. According to some analysts, the average account actually loses big banks over $80 a year. For that reason, they have traditionally functioned as loss leaders, bringing new customers through the door and giving banks the opportunity to sell them more profitable products. Yet in many cases – up to almost 40 percent by some estimates –checking account holders don’t end up using their accounts, or other financial products, enough to cover costs.

2. Over time, operating a checking account has grown more difficult for banks. In the past, these accounts generally included little more than a debit card and monthly statement. But nowadays, customers often expect a number of convenient features, like online and mobile banking services, automated bill pay, free ATM transactions, and remote check deposit capability – each of which adds to the complexity and cost of managing the account.

3. Perhaps most significantly, regulatory changes have made it even harder for banks to squeeze a profit from checking. They had typically underwritten the high costs of account maintenance in part through overdraft fees and debit card interchange fees (the fees paid by a merchant when you use a card to make a purchase). But since the government capped the debit card interchange fees that large banks receive and ended the practice of automatic enrollment in expensive overdraft programs, banks were faced with the loss of tens of billions of dollars in revenue.

It’s safe to say that no customer is going to shed a tear for big banks’ lost profits. But their efforts to recoup these losses have led these banks not only to start charging for checking accounts that used to be free, but to increase ATM and overdraft charges – and to invent a slate of other new fees that skirt existing regulations. To make matters worse, many banks have tried to conceal these changes by continuing to market their checking accounts as free, in spite of opaque balance and deposit requirements designed to trigger additional fees.

In their efforts to capitalize on consumer frustration with the demise of free banking, a number of online/mobile financial services providers have taken to marketing their accounts as entirely fee-free. But in most cases, like brick-and-mortar banks, these providers add caveats and restrictions in the small print.

This reveals a hard (but somewhat obvious) truth that many in the industry won’t publicly admit: banking isn’t free, never was, and never will be. Providing financial services costs money, and that money – one way or another – comes from customers. That’s kind of the point of running a business. It’s true that online banking can reduce overhead and minimize the amount of revenue providers must collect. And it’s admirable that many are trying to eliminate the inconvenience and financial hardship caused by excessive banking fees. But it’s unfortunate that so many are posing as for-profit companies that give away their services for free, rather than simply being transparent about how customers’ banking activity sustains their business model.

We faced a similar decision when we launched Meed, a fintech that connects financial institutions with customers through an intuitive mobile banking platform. We started the company with the dual goal of making banking both affordable and convenient, while spreading these benefits to financially excluded people around the world. But rather than trying to recoup the costs of doing business through a series of opaque policies and hidden charges, we opted for a single monthly fee that is adjusted in every market for purchasing power parity, in this way everyone in the world truly pays the same. We work with member banks to provide a mobile checking and savings account with no minimum balance or overdraft fees, a line of credit collateralized by savings, and money transfers between Meed users around the world – along with mobile check deposit and bill pay, a debit card and other standard features. Other than a maximum 2% foreign exchange fee for international money transfers, the monthly fee is the only charge. And since our goal is to serve people of all income levels, we offer users the opportunity to participate in SocialBoost, which lets them earn a portion of the interest generated by the banking activity of new users they invite into the Meed community. After they invite one or more new users, this income can easily exceed our monthly fee, growing into a useful revenue stream.

We believe this approach offers a solution to the fee dilemma for both banks and customers. Rather than pretending to do business for free, we feel it’s more effective (and more honest) to make the cost of banking transparent – while giving customers the opportunity to not only defray it, but to profit from it.